The Swiss National Bank took everyone by surprise on Thursday by announcing it was scrapping the euro cap on the franc, otherwise known as the exchange rate ceiling or “the floor”. If you have only a vague idea what this means, read on.This content was published on January 15, 2015 - 14:53
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Q: What is the exchange rate ceiling?
A: This was a policy introduced by the Swiss National Bank (SNB), Switzerland’s central bank, in 2011 to stop the Swiss franc from gaining too much in value against the euro. The move was deemed necessary because the eurozone is Switzerland’s largest trading partner and the weakening euro meant that Swiss products were fast becoming unaffordable. Swiss exporters were therefore suffering.
The SNB set a minimum value of 1.20 francs to 1 euro and promised it wouldn’t let the rate go lower than that. To deliver on this promise, it has had to spend vast amounts of money on buying euros over the past three years. Now, in one stroke of the pen, the ceiling – or floor, depending on how you look at it – has been removed and the franc has shot up 30% in value against the euro.
Q: Why scrap it today of all days?
A: It was always going to be difficult to back out of this artificial arrangement without causing a shock to the system, although there may have been the option to make the move in steps. SNB chief Thomas Jordan has said the euro cap has served its purpose, giving Swiss manufacturers time to adjust to the situation. It wasn’t sustainable to hold this course in the long term “on the basis of international developments”, he said, so they bit the bullet.
Those developments included the strengthening US dollar, fears that the European Central Bank will flood the markets with hundreds of billions of euros later this month and the potential of Greece exiting the euro.
Last month the SNB said it would start charging foreign central banks to keep francs on deposit in Switzerland as a way of discouraging too much stockpiling of the franc. The franc is traditionally a safe currency – a so-called safe haven – which banks like to have in their back pockets in turbulent times. This is one of the other ways of preventing the franc from becoming too strong.
Q: So it’s good news?
A: If you’re paid in francs and are planning a holiday abroad, your budget for souvenirs just got bigger. It should also mean cheaper retail prices for the Swiss consumer, as most goods in Swiss shops are imported.
Q. Who’s not happy about this?
A: Traders don’t like surprises of this sort. The initial reaction has been to sell off Swiss stocks – the Swiss stock market is on track to make its largest single-day loss in 25 years.
The other losers are Swiss exporters, who have been happily living with the comfort blanket of the euro cap for more than three years. Today’s news is like an ice bucket challenge for Swiss exporters – without the benefit of doing it for a good cause.
The Swiss trade union federation isn’t happy either. It warned that the decision could cost jobs and affect salaries.
Q: And what does it mean for tourists coming to Switzerland?
A: European, British and American tourists will feel the hit immediately. The meal that cost them the equivalent of €100 last night will cost around €125 tonight. That means cutting back on spending and maybe even considering another alpine destination instead. Swiss hoteliers must feel like crying.
Q: So what happens now?
A: The SNB says it is still committed to ensuring price stability and that it could still intervene in the foreign exchange markets by buying up other currencies, such as the euro. But the exact shape of its future currency strategy remains strangely unclear.
Some economists had predicted the SNB would change its strategy to peg the franc to a basket of currencies, including the US dollar which has been appreciating against the franc. But this has not happened. Instead, the markets have been rather puzzled by a lack of clarity from the SNB over how exactly it will defend the franc in the coming months.
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